The oil and gas market is still red hot, and investors with varying levels of experience want in on the action. While buying stocks of public companies is one route available to all investors, many companies offer other ways for high-net-worth individuals and institutions to invest in E&P. Since the early days of the oil and gas business, clever scams have made it hard for investors to accept "nontraditional" investing opportunities as honest. "The one thing I'm concerned about is the new entries," says John Walker, president and chief executive officer of EnerVest Management Partners Ltd. and outgoing Independent Petroleum Association of America (IPAA) chairman. "I'm concerned that many of them don't have the professional background and direct experience. It just kills the oil and gas market when these guys jump in because it's an attractive market. That's the real 'buyer beware' signal-frankly, if I was an investor I wouldn't invest with anyone who hasn't been around for at least 10 years." Though the strategies may vary, several long-standing nontraditional E&P investment vehicles are available thanks to experienced management teams, tailor-made packages and impressive rates of returns. Here are a few of these. Five States Energy Co. LLC Dallas-based Five States Energy buys properties and partial interests in properties as well as develops non-standard transaction structures for operators that require financing. The company purchases fully developed, operated assets and partial interests in seller-operated properties, often leaving the seller with a reduced interest and retaining him as operator. "We have traditionally raised our capital from accredited individual investors through a network of fee-only financial planners," says Arthur Budge, chief executive. "This has historically made up a vast majority of all of our investors. The balance consists of individuals known personally by the principals. "Our investors are more interested in the 'P' of E&P than the 'E.' For that reason, our partnerships have focused on production acquisition." Each year, Five States forms a new limited partnership that is open to individual investor participation. The partnership purchases working interests in onshore producing properties and distributes cash flows from the properties to investors quarterly. Five States, which manages the partnerships, participates at a 1% carried interest until the limited partners have received cash distributions equal to their original investment. At that point, the general partner receives 25% of the remaining cash flow. Since 1996, weighted average annual cash distributions have ranged from 10% to 28% of investment. Such averages could change depending on the price volatility of oil and gas. At press time, all the partnerships or their successors were still operating. The company was formed in 1985 by James A. Gibbs, an independent producer and consulting geologist. Gibbs, chairman, began investing in producing properties in the 1960s. In 1983, as long-life producing properties became readily available for purchase, he expanded this activity. "He did this for a few years for his own account and with family and friends, then decided to bring in outside investors," Budge says. "He was very specific about the structure of the limited partnerships. His main objective in designing the structure was to ensure that the general partner not get a meaningful share of cash flows until the limited partners had been returned cash equal to their original investment." Five States rarely works on "unique" projects, he adds. "We are a company that really sticks to our knitting. We have adhered to the same business model for the past 20 years and do not ever see diverging much from it. It has worked well for us and for our investors." EnerVest Management Partners Ltd. Houston-based EnerVest Management Partners was created in 1992 to acquire, exploit, operate and manage oil and gas properties for institutional investors. The company raises capital and invests directly in properties, acting as general partner on behalf of investors. Since inception, the company has raised about $1.5 billion. Management includes John Walker, the past IPAA chairman, and James Vanderhider, executive vice president and chief financial officer. Walker was a founder of Nuevo Energy and an energy analyst. Vanderhider was chief financial officer of Nuevo Energy. EnerVest forms limited partnerships in which the investors are limited partners and EnerVest is general partner. "Then these partnerships acquire oil and gas property interests or the oil and gas companies that own the assets," Vanderhider says. Walker adds, "We have many nontaxable investors that can't own direct working interests. EnerVest buys the working interests and we spin out the net-profits interest to them. We are not financiers; we operate." Currently, the company operates 11,000 wells in nine states from Michigan to Louisiana, and the Rockies to the Appalachian Basin. "Our past partnerships have returned- after carried interests, management fees and hedge payments-a 28.1% rate of return," Walker says. Many past exits were in a lower commodity-price environment. At today's prices, the overall rate of return would be in excess of 40%, he adds. EnerVest focuses strictly on returns. "That means you're not trying to build an Exxon, and you're not as concerned about assets under management as you are about rate of return for the investor." Noble Royalties Inc. Dallas-based Noble Royalties has focused on acquiring and managing royalty interests since 1997, working with private, institutional and 1031 exchange investment groups. It was founded by Scott Noble when, after 12 years in oil and gas drilling and operations, he decided that diversified royalty ownership presented the most attractive risk/reward profile in the energy sector. Since 1997, the company has participated in approximately 55 acquisitions representing more than $407 million of invested capital. It has acquired and currently manages royalty, overriding royalty and mineral interests in 42,837 wells in 27 states and offshore, involving more than 4.2 million acres of leases. It does not drill or operate. "We buy a property in advance with my own money and then we bring in the very private, long-term relationships we've had," says Noble, president. "These are people seeking lower returns with lower risk in the energy sector. They do not want to have the excitement or the returns of drilling; they seek a safer avenue in the energy sector." Although most of the company's initial investors were from the Dallas community, it now has a number of real estate investors nationwide that are looking to diversify. The company works with trusts, institutions, banks and other oil and gas firms that may not be set up for handling oil and gas royalty disbursements. Noble Royalties' assets incur no monthly expense or liabilities linked to additional property development, and royalties can produce income not tied to equity and debt markets. "When you study the publicly traded royalty trusts out there, they trade at a 7.5% to 12% yield, which tells you that's where the public market puts royalties when comparing them with fixed-income rates," Noble says. "It puts them fairly close to a risk-free return, if you buy royalties in bulk." The company is currently expanding into royalty fund management to bring the cash flow of diversified private royalty ownership to institutional investors. PetroInvest LLC An Internet-based exchange, Houston-based PetroInvest pairs private-placement drilling partnerships with non-petroleum brokers, broker/dealers and registered financial advisors. The company assists in capital formation for microcap E&P companies and is a source for alternative-investment products for accredited investors. Through the firm, financial advisors find, compare and select partnerships in a standardized format; receive third-party due diligence on the background, financial, geological and engineering aspects of deals; and have a means of increasing the amount of available capital and reducing the overall cost of funding partnerships. At press time, PetroInvest was in the process of closing its first $14-million program. Steven King, chief executive, hopes to close another $20-million-plus in two more programs by year-end. "We provide a platform where the non-petroleum investment advisors, representing high-net-worth individuals, can choose from multiple opportunities at one place," King says. "Probably the aspect these investment advisors like most is the strong third-party due diligence we require." King was among founders in the late 1980s of Newfield Exploration Co. and was with Tenneco Oil Co. in its Gulf of Mexico business unit prior to that. The concept of PetroInvest came to King after he realized there were untapped sources of capital in E&P. After reviewing private-placement memorandums from clients, he was shocked. "It wasn't the large amount of boilerplate in the document, it was the lousy economics of the investment. The major problem was the excessive upfront fees, usually masquerading as turnkey drilling mark-ups. "But I did appreciate these programs were tapping into a source of capital that the large number of microcap companies didn't know about. Then I compared the returns the oil and gas company could make using partnerships instead of the standard third-for-a-quarter industry farm-out. "And I also knew investors could do better by just following what the industry does. Instead of 10-plus-year payout programs, they should be looking at the same plays as the majority of the oil and gas industry. After that, I just had to figure out how to connect these two large groups." Petroleum Development Corp. Bridgeport, West Virginia-based Petroleum Development Corp. offers investors direct investments in oil and gas drilling through public limited partnerships. The publicly traded company (Nasdaq: PETD) has drilling and production operations in the Appalachian Basin, Michigan and the Rockies. In partnerships, it acts as managing general partner. "We started forming partnerships in 1984 because it was an additional way to access capital to develop prospects," says Steven R. Williams, chief executive and president. "We had more prospects than we had capital. By inviting in additional investors, we were able to develop our properties, and through the fees that we received as project managers, we were able to buy more interests in wells." Petroleum Development began in 1969 in the Appalachian Basin. In 1997-99, it expanded to Michigan and the Rockies. Between 1998 and 2002, the company drilled some 800 new wells. In 2003, it invested more than $40 million in property acquisitions. Today it operates more than 2,700 wells and realizes more than 81% of its production from more than 1,000 wells outside the Appalachian Basin. It now has 75 partnerships. Stakes in each partnership are sold through a nationwide network of broker-dealers. "The brokers can take a partnership investment and put it into an overall financial plan or use it as a stand-alone investment with their clients. The client has a tax advantage and can deduct about 89.5% of his investment. He will have a direct interest in a number of new oil and gas wells that we drill." In 2001 and 2002, the company raised about $57 million per year in these partnerships. It strives to form four each year, closing one each in April, September, November and December. Williams has been with the company since 1983 and became chief executive in 2004. Previously, he was with ExxonMobil, Texas Oil and Gas, and Exco Enterprises. Thomas E. Riley, president, was president of Riley Natural Gas Co., a gas-marketing company Petroleum Development acquired in 1996. At press time, the company was in the process of restating its financial results for the past five years, due to accounting errors involving derivatives positions. The company does not expect the accounting issues to affect partnership investors' returns or the company's cash flow. Bradley Energy U.S.A. Inc. Beginning mid-year 2004, Scottsville, Virginia-based Bradley Energy has offered a series of drilling programs aimed at developing gas reserves in the Appalachian Basin through its affiliate, Bradley Energy LLC. These programs are available to accredited investors and commercial entities. Subscribers are assigned working interests in completed wells, and enjoy unique tax benefits. Ralph L. Bradley, chief executive, formed Eastern States Exploration Co. in 1981 that grew into The Eastern Group, which operated more than 2,000 Appalachian Basin wells and was sold in 1997 to Statoil. He then formed Bradley Energy, which has since invested in drilling ventures involving more than 200 gas wells in Pennsylvania and West Virginia. The company's working interest in these ventures ranges from 3% to 90%. "Gas production from the mid-year 2004 venture is just beginning, so returns based on actual results cannot be determined at this time," he says. Data so far suggest that more than 90% of the wells drilled to date are commercial. While the company continues lease acquisition activities and development of gas reserves in the basin, Bradley U.S.A. is also pursuing development of domestic unconventional energy resources.